Aseem Chawla

The Finance Ministry, keeping in pace with the international tax laws, has proposed an introductory version of the participation exemption regime in India.

Under the international tax regime, the term ‘participation exemption’ provides the exemption from all the benefits derived by the shareholders by virtue of the shareholding. In principle, the benefit comprises dividends, interest and cap ital gains.

Conceptually, the principle of participation exemption is based on a combination of the idea of not taxing profits twice in the corporate tax sphere and the idea of treating a group as one whole.

There are several countries which have adopted the participation exemption, namely, EU countries following the EU parent/subsidiary directive — the Netherlands, Belgium, Switzerland, Hungary, etc. It seems that the Finance Minister has acceded to the demand of the ever growing need of Indian multinationals, albeit in a half-hearted manner.

However, it is a welcome gesture

An amendment in Section 115-O of the Income Tax Act, 1961 has been proposed by inserting a Section (1A) after Section (1) to Section 115-O of the Act.

In terms of the proposed Section (1A), the amount of dividends referred in Section (1) of Section 115-O of the Act shall be reduced by the amount of dividend, if any, received by the domestic company during the financial year if:

such amount of dividend is received from its subsidiary;

the subsidiary has paid tax under this section on such dividend;

the domestic company is not a subsidiary of any other company.

In a domestic two-tier structure, the holding company would not be liable to pay DDT on the dividends distributed to its shareholders to the extent of dividend received by its subsidiary. In essence, the benefit would not be available either entirely or partly in a situation where a foreign holding company or Indian holding company has multi-tier structures in India.

Internationally, countries are granting participation exemption to all the corporates whether incorporated inside or outside the country, subject to conditions for the corporates incorporated outside India.

For instance, under the Dutch corporate tax laws, the participation exemption is applicable to shareholdings in both domestic and foreign corporates.

However, the Dutch law provides certain conditions for the foreign corporates, for example, all participations in entities resident outside the Netherlands must be subject to an income tax in their country of residence.

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